Impact of stewardship codes in the UK and Japan – Lessons for the US?

Following its publication in 2010, the UK Stewardship Code quickly became a global trendsetter. Similar guidance has since followed in Brazil, Canada, Japan and other Asian countries, Kenya, South Africa, several European countries and even in the US. As stewardship codes continue to surface across the globe, Dr Hans-Christoph Hirt, Head of Hermes EOS at Hermes Investment Management, assesses the impact and success of implementation in the UK in comparison to its Asian and American counterparts.

Drivers for maximum impact

The introduction of stewardship codes or similar guidance around the world has encouraged investors to monitor the companies they invest in, engage with them on a wider-range of issues and to exercise their vote. While the codes are very welcome, questions marks do hang over their impact – how much have they really changed investor behaviour?

Based on our experience, four factors are likely to aid their success and impact namely 1) Support from local asset owners, particularly major ones, which is reflected in them becoming early signatories, investing in resources and challenging their fund managers, 2) The driving force of a regulator and possibly the government, 3) Sufficient interest from foreign investors and 4) A regulatory environment that provides legal certainty for investors around the ways they can collaborate and on which issues they can do so.

UK: Ahead of the curve or room for improvement?

The regulatory underpinning of the UK Stewardship Code by the Financial Conduct Authority (FCA), its oversight by the Financial Reporting Council (FRC) and the initial explicit support of the representative bodies ensured that it was widely adopted by fund managers and by a good number of asset owners – at least on paper. While it has gained hundreds of signatories, the FRC among others has questioned the commitment of many and thus the impact of the code for a number of years. It introduced disclosure-based tiering of code signatories in 2016, facilitating better transparency and more accountability of signatories. This summer, the FRC abolished its bottom tier 3 category after some improved their disclosures, and others chose to remove themselves from the list entirely. Through the Investor Forum, the UK has also become the first market with an institutionalised form of engagement collaboration between investors – domestic and international. The country seems unique in that all four stewardship success factors appear to be present and yet even in the UK questions around success remain.

Japan on the right track

Elsewhere, the Japanese regulator has recently tightened the requirements of its Principles for Responsible Institutional Investors – which launched in 2014 and had 214 signatories at the end of 2016. The country’s Financial Services Agency had committed to regularly reviewing the principles and we have largely welcomed their proposed amendments to the principles, particularly the note on collaborative engagement. Although substantial cross-shareholdings of companies remain an obstacle to effective stewardship activities, Japan appears to be on the right track. It is important to note, however, that relative to other Asian markets the country is in a unique position as its government, regulator and biggest pension fund have all been driving for enhanced levels of investor stewardship. What seems to be lacking in Japan is the experience and culture of constructive engagement between investors and companies and – crucially – clear rules around collaboration.

The US takes first steps

The Framework for US Stewardship and Governance, which was launched earlier this year by a group of prominent US institutional investors, is notable and welcome. It is the country’s version of combined stewardship and governance codes and will take effect from the beginning of 2018. It is a significant step forward in the evolution of corporate governance in the US, where regulators and stock exchanges lack the will to enact their own codes and the current administration appears to have no intention to act in this area. While both codes lack a formal monitoring and review mechanism and could certainly be more stretching, we have become an endorser of the US Investor Stewardship Group, which developed the framework and will be arguing for stronger provisions and more ambition. In the absence of a regulator driving the framework and with collaboration among the large asset managers currently fairly limited, we fear that initially the US stewardship guidance will not have a significant effect, but that it exists at all is a sign that even in the US the concept of stewardship is growing.